payments. In arranging international payments, banks facilitate international transactions by, on one hand, offering facilities that enable the creation of payment documents that foreign banks accept and, on the other hand, by accepting payment documents that foreign banks have issued. By using international payment networks between banks, banks can also send payments according to their customers' requests.
1.1.5 Other Banking Services
Apart from its core services, a bank usually offers other financial services, sometimes in competition with nonbank financial service providers that typically include finance companies, brokerage firms, risk management consultants, and insurance companies. Banks and the companies offering these services typically receive fees, or “fee income,” for providing these services.
Fee income is the second main source of revenue to banks after the interest the bank receives from its borrowers. Other banking services may include:
• Cash management. As a part of their core deposit collection and arranging payments function, banks provide cash or treasury management services to large corporations. In general, this service means the bank agrees to handle cash collection and payments for a company and invest any temporary cash surplus.
• Investment- and securities-related activities. Many bank customers demand investment products – such as mutual funds, unit trusts, and annuities – that offer higher returns, with higher associated risks, than bank deposits. Historically, customers have turned to nonbanks for these investment products. Today, however, most banks offer them in an effort to maintain customer relationships.
Banks also offer other securities-related activities, including brokerage and investment banking services. Brokerage services involve the buying and selling of securities (e.g., stocks and bonds) on behalf of customers. Investment banking services include advising commercial customers on mergers and acquisitions, as well as offering a broad range of financing options, including direct investment in the companies themselves.
• Derivatives trading. Derivatives such as swaps, options, forwards, and futures are financial instruments whose value is “derived” from the intrinsic value and/or change in value of another financial or physical asset, such as bonds, stocks, or commodities such as gold or oil. Derivative transactions help institutions manage various types of risks, such as foreign exchange, interest rate, commodity price, equity price, and credit default risks. Derivatives and their use are discussed in Chapter 6.
• Loan commitments. Banks receive a flat fee for extending a loan commitment of a certain amount of funds for a period of time, regardless of whether the full amount is drawn down by the borrower. When the borrower uses the loan commitment, either in full or in part, the used portion of the commitment is recorded on the bank's balance sheet. The unused portion remains off its balance sheet.
• Letters of credit. When a bank provides a letter of credit, it guarantees a payment (up to the amount specified in the letter of credit) on behalf of its customer and receives a fee for providing this guarantee.
• Insurance services. Many banks, particularly those outside the United States, offer insurance products to broaden their customer base. Insurance services are a logical progression for banks since insurance products have financial intermediation and asset transformation features similar to traditional bank products. Life insurance policies, for instance, are often similar to many of the long-term deposit products that banks offer: all are savings tools, but they deliver their savings benefits differently.
• Trust services. Some bank customers, particularly wealthy individuals, corporate pension plans, and estates, prefer to have professionals manage their assets. Therefore, many banks offer trust services that professionally manage a customer's assets for a fee. These assets under management do not show up on the balance sheet of the bank.
• Risk management services. As banks have expanded into more complex businesses, they have had to confront more complicated and composite risks such as interest rate, exchange rate, and price risks. Banks have developed sophisticated skills and complicated tools to manage these complex risks. For a fee, banks now offer the same risk management skills and tools to their customers.
This section illustrates different types of banks by focusing on the types of customers served and the range of services offered. Variations of the types of banks described here exist in different parts of the world.
1.2.1 Retail Banks
Retail banks' primary customers are individuals, or “consumers.” Many retail banks also offer services to small and medium enterprises (SMEs).Retail banks may have different specializations:
• Retail and consumer banks, savings and loans companies (thrifts, building societies), cooperatives, and credit unions. These offer loans primarily to individuals to finance house, car, or other purchases (e.g., Woodlands Bank in the United States, TSB Bank in the United Kingdom, or OTP Bank in Hungary). The particular features of cooperatives and credit unions are addressed below.
• Private banking firms. These provide wealth management services, including tax and investment advice, typically to rich individuals (e.g., Coutts & Co. in the United Kingdom and Bank Julius Baer in Switzerland).
• Postal banks. These offer banking services to customers in post offices. This structure, where the postal service owns or collaborates with a bank, is widely used throughout the world (e.g., Postbank A.G. in Germany, Japan Post Bank in Japan).
Although retail banks can come in many forms, most have a network of local branches that enable them to focus on retail consumers in one specific geographic area such as a city or a region of a country. However, there are a number of very large retail banks that have extensive branch networks that cover entire countries or portions of countries (e.g., HSBC and Industrial and Commercial Bank of China) and link to retail branches in networks owned through their affiliated entities in other parts of the world (e.g., Citigroup and Santander).
1.2.2 Wholesale Banks
Wholesale banks' customers are primarily corporate and noncorporate businesses. Although the range of business customers varies, it usually includes larger domestic and international companies. Wholesale banks also offer advisory services tailored to the specific needs of large businesses. Types of wholesale banks include:
• Commercial banks. These offer a wide range of highly specialized loans to large businesses, act as intermediaries in raising funds, and provide specialized financial services, such as payment and risk management services.
• Correspondent banks. These offer banking services to other banks, often in another country, including loans and various investment alternatives.
• Investment (sometimes called “merchant banks”). These offer professional advice to corporations and governments about raising funds in the capital markets such as the stock, bond, or credit markets. In the case of companies, they also provide advice on buying or selling companies as a whole or in part. In the case of governments, they will advise on privatizing public assets. They may also serve as underwriters and investors in these activities.
BANKING IN FOCUS
The number of investment or merchant banks has diminished since 2008 due to the effects
